Joint Ventures in Real Estate
In the last 5-years, the Kenyan real estate sector has performed well, realizing returns of above 20.0% p.a for investment grade real estate and thus attracting the interest from landowners and investors. The main ways to invest in real estate include (i) development and exit through selling or renting out, (ii) buying real estate products to realize capital gains and rental yields, and (iii) buying real estate-backed structured products such as project notes and Real Estate Investment Trusts (REITS). Landowners, in particular, are increasingly interested in real estate development but are constrained by (i) financial capability, (ii) development expertise, and (iii) time to do the development themselves. Unknown to many, joint venture arrangements with reputable developers is the most prudent way to tap into the real-estate-benefits. This week, we demystify real estate joint ventures and highlight their benefits.
What is a Joint Venture?
A joint venture (JV) refers to a business arrangement under which two or more parties come together to undertake a project by pooling their resources together. In their most distinctive form, real estate joint ventures combine the real estate development expertise and financing capability of a developer with the landowner’s contribution in the form of land.
The Joint Venture Process
The following are the steps involved in a joint venture;
- Project Appraisal - The first step always involves appraisal and usually begins with a site visit by the developer to identify the location of the property, its accessibility, the availability of infrastructure, the soil type, the terrain and other factors that affect development. The developer will then conduct a feasibility study to establish the best use of the property, project costs, revenues and the resulting potential returns from such an investment,
- Project Proposal - The developer will then come up with proposal for the landowner showcasing the proposed concept, the budget, the revenues and the profit-sharing between the two parties,
- Legal Due Diligence - When the landowner accepts the developer’s proposal, they are required to avail copies of the land title deed and deed plans for verification by the developer’s advocate. The advocate will conduct a search to establish the authenticity of the title deed, true ownership and that the land is free of any encumbrances. A surveyor will then be engaged to verify the beacons on the ground and confirm acreage on the title compares with the one on ground,
- Signing of Agreements - Once due diligence is complete and is satisfactory the developer drafts a Joint Venture Agreement (JVA) and sends to the landowner’s advocate. Of the many challenges inherent to a JV, an agreement outlines all possible scenarios that might be a source of conflict and forges a path forward in the event that anything does not go according to plan. The following are some of the common clauses found in a JVA:
- The capital obligations of each party,
- The partnership management structure,
- The rights and responsibilities of each party,
- Exit rights and transfer rights with respect to the sale or transfer of membership interests in the JV,
- The downside protection for the land value contributed by the landowner, and
- The profit sharing mechanism.
Both parties sign the Agreement once they agree to the terms and conditions laid out.
- Formation of a Special Purpose Vehicle (SPV) - Upon signing of a JVA, a special purpose company is formed with the aim of fulfilling the objectives of the JVA. The company is then registered as a private Limited Liability Company (LLC) or as a private Limited Liability Partnership (LLP) by the registrar of companies,
- Transfer of Land to the SPV - Once the company is formed, the landowner is required to avail the title deed and other relevant documents required for the transfer of the land ownership in favor of the SPV,
- Project Commencement - The developer then begins execution of the project through procuring of the project team including the architect, project manager, the engineers and other consultants. The developer oversees the project through to completion,
- Project Completion - Once construction is complete, the landowner and the developer share profits in accordance to the terms of the JVA. Profits shared may be in form of cash or units such as houses or apartments.
Benefits of a Joint Venture
Joint ventures, if done correctly, can be a source of financial fulfillment for both parties. The following are some of the benefits of a JV;
- Increased capital base - In a JV, partners contribute capital into the project in the form of land and/or cash. This is beneficial considering the capital-intensive nature of real estate development. Furthermore, with seed capital, the partners are able to access debt capital easier as they have a higher bargaining power,
- Development expertise - The developer in a JV provides development expertise in terms of concept development, design and project management; and oversees the project to completion. With the right partner, the landowner is relieved of the day-to-day hustle of supervising a project and assured of a professional workmanship,
- Access to market distribution channels - Partnering with a reputable real estate firm that has been in the market ensures the real estate product reaches its suited market, and thus is able to exit faster either by renting or selling, thus realize returns sooner,
- Can provide partial liquidity for landowner without having to sell the entire land – In a JV, the land owner can get some cash exit for their land to meet their liquidity needs and also maintain interest in the development,
- Preferred Returns – Landowners should insist on either preferred or guaranteed minimum returns to ensure that in the event that the project does not materialize, they do not lose the value of their land, and
- Shared risks and gains - Ultimately, a successful JV will generate the expected high returns for both partners. A partnership also enables spreading of economic and other market risks that might result from undertaking any worthy real estate investment, and that would otherwise be borne alone.
The biggest risk and challenge in joint ventures is getting the right JV partner and having the right governance structure to manage conflicts when they arise. For the investors, as you get into a joint venture, it is good to set out the rights and obligations of the various parties in the SPVs and ensure you have downside protection for the value of the land.
Cytonn Real Estate has now engaged in over 1,150 acres of joint ventures in Nairobi Metropolitan Area. To explore JV opportunities with Cytonn Real Estate, contact firstname.lastname@example.org